BISNIS - NIS Agribusiness Report

Agribusiness Presents Investment Opportunities in Southern Russia

**Note: this article will be featured in the "BISNIS Bulletin". Editorial comments are welcome.

The increasing focus, since 1993, of U.S. industry on exports of meat and high value processed foods to Russia has, in many instances, obscured similarly promising investment opportunities for U.S. companies in Russian food production. This is especially true with respect to the fertile "black earth" regions of Southern Russia including the Voronezh, Saratov, Volgograd, Rostov, Krasnodar and Stavropol oblasts. The openness of the Russian market to high quality food products, the enormous agricultural potential of Southern Russia and the likelihood that increased import duties will lower demand for foreign imports all suggest that U.S. companies with a long-term interest in the Russian market should consider taking advantage of opportunities in this region.

Demand for High Quality Food Products

A steady decrease in Russian food production since 1992 has provided an incentive both for foreign importers and private domestic producers to compete with collective farms and inefficient state-owned processing combines. In 1993 and 1994 Russian food production fell an average of 15 to 20 percent each year. Current prospects appear equally poor with declines in the first five months of 1995 ranging from 17 to 35 percent in meat and dairy production and averaging 12 percent for other staples. In the case of agricultural enterprises, shortfalls have been due to arbitrarily low prices offered by state-owned processing combines coupled with increasing costs for inputs and decreasing state subsidies. The processing combines, in turn, suffer from outdated equipment and structural inefficiencies including overemployment which prevent them from offering adequate incentives to farmers.

To date, higher quality, better packaged imported food products have been most successful in compensating for the decline in domestic production. In 1994, Russia was the leading market for U.S. poultry with exports valued at over $300 million. Russia also ranked in the top 10 for U.S. exports of dairy products, alcoholic beverages and snack foods. Large U.S. corporations such as Tysons chicken, Mars Inc. and Nabisco International have all generated healthy profits in the Russian market. According to an estimate published in the Economist magazine, Masterfoods, a Russian subsidiary of Mars Inc., sold $450 million in chocolate bars and pet foods in 1994, granting it a 35 percent share of the entire market for those products.

In some cases, domestic producers have been successful in taking advantage of opportunities in the Russian food industry. Most notable are small private food processors which have been able to establish direct links with agricultural enterprises as a means of competing with state-owned processors. In Nizhny Novgorod, this formula was instrumental in the creation of nearly 2000 food processing enterprises in 1991 alone. More recently St. Petersburg has exhibited similar tendencies with a number of meat and dairy processors demonstrating an ability to obtain foreign financing. The newly privatized "Samson" meat processing facility in St. Petersburg is an example, having obtained $4.5 million in financing for German equipment to modernize its production line. Nevertheless, these processors are typically limited by the agricultural enterprises which continue to face the financial and structural barriers noted above. Lacking the financing to fully integrate the entire process, domestic producers cannot usually produce the level of quality and efficiency necessary to compete with foreign imports.

The Agricultural Potential of Southern Russia

It is in light of these difficulties that advantages available to U.S. companies in Southern Russia are most evident. Blessed with deep, rich top soil, the "black earth" region currently produces more than 10% of the total annual farm output of Russia and was known as a major grain exporter prior to the Soviet era. As in the rest of Russia, both the farming and food processing sectors suffer from financial and structural deficiencies often requiring that successful foreign ventures address problems in both. Yet the superior quality of farmland in Southern Russia and the possibility of integrating processing facilities in close proximity to agricultural enterprises makes the region an ideal locus for foreign investment. The priority which food production enjoys in the minds of local officials can also improve the environment for foreign investors. During a recent visit by the U.S. Commercial Service in Voronezh, the Chairman of the Regional Committee for Foreign Economic Relations placed the improvement of the regions food processing and storage facilities as his first priority in terms of investment projects.

In recognition of these advantages, a number of U.S. companies have already established agricultural ventures in Southern Russia. The Iowa-based ConAgra is presently growing potatoes in Krasnodar which, among other things, will be used to make french fries for Macdonalds. Monsanto, Cargill and Petoseed are also active in a variety of agricultural enterprises including corn, sunflower, soya, popcorn and vegetable seed production. In terms of food processing Heinz has been at the forefront with a $20 million baby food plant in Stavropol.

New Taxes and Import Duties on Food Products

Another factor which is likely to make Russian-based food production more attractive to U.S. companies is the considerable increase in taxes on food imports which became effective on July 1, 1995. Higher tariffs, combined with a newly imposed 10 percent value added tax (VAT), have raised overall taxes on food imports an average of 15 to 18 percent with taxes on a few items increasing as much as 30 percent. Urban regions including Moscow and St. Petersburg which were shielded from past increases are equally subject to these taxes.

While the current value of the ruble vis-a-vis the U.S. dollar will compensate somewhat for higher costs to importers, U.S. companies have reason to be concerned about the long term. The ruble's recent past, notably its crash last October, does not inspire confidence that it will sustain its current standing without fluctuation. The effects of the IMF-imposed stabilization package which is a principal source for the ruble's appreciation are still too new to be entirely predictable. Secondly, if food prices increase as expected (irrespective of the ruble's value) companies importing high value foods will not be able to count on the consistent demand for their products enjoyed by those importing staples. Reflecting these concerns, a spokesperson for Nabisco International, which has generated 80 percent of its sales in Russia through the import of nuts, commented in May 1995 that a proposed 19 percent increase in import taxes was prompting the company to reconsider its entire market strategy.

Taking the First Steps

How should U.S. firms take advantage of opportunities in Southern Russia? Careful research leading to the development of a comprehensive market strategy is a key ingredient. The slow rate of privatization in Russian agriculture typically requires foreign companies to enter into partnerships with existing enterprises, including food storage, processing and distribution facilities as well as farms. In response to this situation, John Balis, director of the Food Systems Restructuring Project which provides grants for agribusiness development in the region, noted that U.S. companies should be prepared "to work the whole system." According to Balis, those foreign companies most successful in Southern Russia find that they "need to establish a vertically integrated system to get quality product."

Financing is also a substantial hurdle. Given the current crisis in Russian agriculture, U.S. companies should assume that they will have to take on the bulk of the financial burden. Local banks do not typically provide credits on reasonable terms, necessitating the use of foreign capital. In some cases, programs available through the U.S. Agency for International Development (USAID), the Overseas Private Investment Corporation (OPIC) and the U.S. Export Import Bank can be of assistance. Notable among these are the USAID Food Systems Restructuring Project described above, a new OPIC-sponsored investment fund devoted specifically to U.S. agribusiness ventures in Russia, and the USAID-sponsored U.S.-Russia Investment Fund which invests in Russian enterprises and U.S.-Russian joint ventures.

For more information on these and other programs which can assist U.S. companies in taking advantage of agribusiness opportunities in Southern Russia, call BISNIS at (202) 482-4655 or email at bisnis@usita.gov.